Despite superior returns, investors cool on socially responsible funds

Institutional investors have been more receptive than organic-eating, Prius-driving retail investors

(Thomas Trutschel/Photothek/Getty)

Socially responsible investing screens for environmental, social and corporate governance factors when picking companies to invest in, but that doesn’t mean SRI funds don’t also invest in extractive industries. (Thomas Trutschel/Photothek/Getty)

Investment managers, advisers and bankers gathered in Montreal in 2007 for what was supposed to be an industry-changing announcement. RBC was launching three socially responsible funds. It would be the first Canadian bank to enter the space, which had existed on the do-good margins of Canada’s investing scene since the 1980s.

Sucheta Rajagopal, a fan of socially responsible investing (SRI), was thrilled. “There was a huge buzz in the room,” says Rajagopal, a portfolio manager with Toronto’s Jacob Securities. “Having a major bank enter the SRI space made it more legitimate and more visible.”

Sadly for the sector, that excitement soon dissipated. The recession hit, people lost interest in SRI, and many institutions folded or neglected their funds. In 2009, there were 57 SRI mutual funds in Canada. Today there are 40. Retail assets have shrunk 12% since 2011, according to Morningstar.

Socially responsible investing is broadly defined as investing in companies that take environmental, social and corporate governance (ESG) issues into account. That can mean making sure a business pays its workers fairly or recycles its  waste. Some fund companies focus on one aspect of ESG; others pay attention to it all. In practical terms, investment decisions are usually made by applying a “negative screen” to exclude organizations that don’t meet the criteria, then selecting, using conventional methods, from those that do.

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It’s hard to explain the lack of interest, considering investor activism and public concern over corporate conduct seem to be hitting new highs. Those in the industry point to a misperception that investing responsibly means sacrificing returns. All the evidence, however, suggests the opposite. The Jantzi Social Index, modelled after the S&P/TSX 60 and made up of companies that pass a set of broad ESG criteria, is up 55% over the past five years, while the S&P/TSX 60 has climbed 47%. In the U.S., the Calvert Social Index, an index of 700 large- and mid-cap firms, is up 130% since April 2009, compared with 119% for the S&P 500.

Academic studies have likewise concluded that strategies informed by SRI outperform the broader markets. In 2012, Alex Edmans, a Wharton School professor, found that between 1986 and 2011 the shares of Fortune’s 100 Best Companies to Work For returned 3.5% more a year than their peers. That outperformance makes sense to Rajagopal. “These companies do a good job with work-life balance, compensation and promotion,” she says. “People are happier, there’s less turnover, and everyone’s more productive. That goes to the bottom line.” Other observers suggest SRI serves to lower investors’ risk, for example, by screening out a BP PLC before the Deepwater Horizon disaster or a Barclays before the Libor scandal.

Regardless, the point is lost on most investors. “Many of us believed there would be a tipping point where SRI gained in popularity at the retail level, but it simply hasn’t happened,” says Doug Watt, an Ottawa-based writer, who along with Rajagopal authors the SRI Monitor blog. It is up against inertia in the financial industry: Advisers seldom recommend SRI options, and their clients seldom ask.

Even investors who are environmentally conscious are reluctant to invest in SRI. “People in my area pride themselves on driving Priuses and eating organic foods,” says Patrick Costello, a San Francisco–based certified financial planner and author of Green Investing: More than Being Socially Responsible. “But when it comes to their money, the retail investor is the least interested group in SRI.”

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In their defence, SRI can be a confusing space to navigate, in part because many SRI funds resemble traditional ones. Salman Ahmed, Morningstar Canada’s associate director of active funds research, points out that NEI Investments’ Ethical Special Equity fund, which is sub-advised by Calgary’s QV Investors, is identical—save for one company—to QV’s Canadian Small Cap Pooled Fund.

Most Canadian SRI funds also hold stocks in extractive industries, even as they filter out tobacco, alcohol and gambling stocks. It’s hard to avoid the energy and materials sectors that make up 40% of our market. These companies are nonetheless screened for ESG principles. Suncor Energy, for instance, has strong environmental management systems, is reforesting land, has a good health and safety record and has led a number of carbon-reduction initiatives, says Bob Walker, vice-president of ESG services at NEI. Still, having these inherently unsustainable sectors in SRI funds makes it hard for some socially minded investors to see the point.

Rajagopal remains confident the sector can win over investors one at a time. “There won’t be a huge breakthrough,” she says. “But we will see slow and steady improvement.”